A bank is going to issue $5,000,000 in 10-year par value bonds that pay a 6% annual coupon.The bank must pay .5% of the face value in floatation costs.What is the bank's effective cost of borrowing?

Question

Quizplus · Accepted Answer

First, we need to calculate the total floatation cost, which is 0.5% of the face value of the bonds:
0.5% * $5,000,000 = $25,000
Next, we need to calculate the annual interest payments:
6% * $5,000,000 = $300,000
We can use the following formula to calculate the effective cost of borrowing:
Effective cost of borrowing = (total interest payments + total floatation costs) / total proceeds
Total proceeds = face value - floatation costs = $5,000,000 - $25,000 = $4,975,000
Effective cost of borrowing = ($300,000 + $25,000) / $4,975,000 = 6.1%
Therefore, the answer is B.

A Bank Is Going to Issue $5,000,000 in 10-Year Par